Global Economic Trends: A Conversation with Joseph E. Stiglitz

University Professor, Columbia University; Author, "Freefall: America, Free Markets, and the Sinking of the World Economy"

Presiders

Steven R. Weisman

Editorial Director and Public Policy Fellow, Peter G. Peterson Institute for International Economics

STEVEN R. WEISMAN: Good morning, everybody. Welcome to today's Council on Foreign Relations meeting with Professor Joseph Stiglitz. My name is Steve Weisman. I'm editorial director and public policy fellow at the Peterson Institute for International Economics.

I'd also like to welcome members of the Council on Foreign Relations around the world who are participating in this meeting via teleconference -- very exciting to have you.

The usual reminder to please completely turn off and not just put on vibrate your cell phones, BlackBerrys, wireless devices, social networking devices --

JOSEPH E. STIGLITZ: (Laughs.)

WEISMAN: -- to -- it's to avoid interference with the sound system. And as a final reminder, this meeting is on the record.

It's a pleasure and an honor to present Professor Stiglitz, professor of economics at Columbia and possessor of the Nobel Prize in economics, as well as many battle scars --

STIGLITZ: (Laughs.)

WEISMAN: -- from his time in the Clinton administration when he was chairman of the Council of Economic Advisers, and at the World Bank when he was chief economist and a lively and acerbic critic of the policies of the IMF in the Asian financial crisis. Many of those critiques have come back to sound familiar.

After 9/11, we learned the phrase "asymmetrical warfare." But long before that, Mr. Stiglitz pioneered the concept of asymmetry in economics in which he showed that markets do not function in a pure way, because the various parties have different levels of information and sophistication. And that work transformed economics and led to the insights that he brought to the ensuing crises and to the current crisis.

I won't summarize his views. He's better at that than anyone. His book is in the lobby -- his new book "Freefall," which I've enjoyed reading. And without further ado, let me start off with questions for about a half hour, and then we'll take questions from the audience.

Well, we are meeting at a very tumultuous week, politically. We're not going to talk about health care today, unless someone insists. But let me ask you first, Dr. Stiglitz, to frame the discussion about where you think the economy and the world economy is right now. What kind of moment is this? And if we're coming out of this recession, what do you think is the most urgent agenda item for this Congress, which would be, what, another stimulus, more regulation of the banking system, bank tax, bank fee, tax on bonuses?

STIGLITZ: (Chuckles.) Okay. Those are big questions. But let just begin by saying, you know, obviously we've pulled back from the precipice that the economy felt that it was on a year ago last fall. But I don't think anybody would describe the current situation as a strong recovery. Officially, the recession may be over in the way the economists define recession, which is two-quarters of negative growth -- (if ?) growth is positive -- but in terms of the way individuals feel, they worry about jobs, the way business feels, whether they can sell the goods they produce -- in those terms, the recession is far from over.

In terms of jobs, the official unemployment rate is 10 percent. But that number really masks what -- how bad things are. You're not unemployed if you're not seeking a job. And we've had this recession going so -- on so long that a lot of people who would like a job have just given up, have given up looking for a job. And those aren't included in the unemployed.

So if you take -- but the Bureau of Labor Statistics collects data on that, and there's -- so there's a broader measure of unemployment that includes those who have taken a part-time job because it's the only job available; who've dropped out of the labor force because there are no jobs. That broader number is now over 19 percent. So almost one out of five Americans who would like a full-time job cannot get one now. So this is -- this is a serious situation.

Four out of 10 of those who are unemployed, in the official statistic, have been unemployed for more than a half a year. That's important, because if you're unemployed just for a few weeks, you have something to draw upon and you have -- you know, if you're unemployed for more than six months, you use up your savings and you start actually deteriorating your human capital --

WEISMAN: Right.

STIGLITZ: -- as -- and the prospects of reemployment in a good job go way down. So for all these workers who've been unemployed now, for, say, half a year, their prospects are getting bleaker and bleaker. And that's particularly true of those who are -- who are over 50.

If you look at particular categories of people in the United States, say, young Afro-Americans, the unemployment -- the official unemployment rate now is close to one out of two, 40 -- it's over 48 percent. So if you look in those statistics, things are very bad.

Now, you asked the question, how long is it going to be before we get back to normal? In some of what you hear -- and the media says, oh, jobs lag recovery. But the real fact is, the recovery hasn't been strong enough to create the jobs for the new entrants in the labor force. If every year we have about 1 percent -- growth of the labor force of about 1 percent, and productivity -- that is output per hour -- goes up by about 2 percent, that means if growth isn't over 3 (percent), 3-1/2 percent, it's not strong enough to create the jobs for the new entrants in the labor force. No one sees -- and things always can happen -- but no one sees growth in 2010 and 2011 being above that, let alone enough above that to get the unemployment rate down from 10 percent back to normal 5 percent. So when you're looking at the horizon, you have to be a little bit pessimistic.

The fundamental problem can be put maybe simply both nationally and globally as the following: Would it sustain the American economy and to some extent the global economy in the years before the crisis was a bubble? The bubble allowed people to live beyond their means, in a sense. They could -- they could borrow. They could -- in one year alone, people took $950 billion out of their house. Savings rate for the United States went down to zero.

One of my predecessors, as chairman of the Council of Economic Advisers, said what -- that which is unsustainable won't be sustained. (Soft laughter.) And a savings rate of zero is not sustainable. So savings has gone up.

With -- the flip side of that is consumption has gone down. For the long run, that's a good thing. For the short run, it's a problem. So it's a little bit ironic that, you know, now a lot of people are saying we're praying for the consumer to come back. Well, that's a funny kind of prayer, because it's praying to go back to this dream world that we had before the crisis where we were living beyond our means. And we can't and we shouldn't do that. Because we can't and we probably won't, it's going to be hard to have a robust recovery.

So then that comes to the last part of your question. With consumption weak, it's very hard to have strong investment. In the past, like in the '97-'98 crisis, when Korea, for instance, had a problem, it recovered very quickly, but largely based on exports. But with Europe having a problem, the U.S. having a problem, we all can't export our way out of the crisis.

You know, I jokingly say, you know, trade with Mars is still not big enough. (Soft laughter.) So the fact is that because all of us are there in the same boat, exports is not going to be able to get out.

Now, one part of the world, Asia, is recovering, but while Asia is very dynamic, relative to Europe and the United States, it's just too small to make up for the shortfall. And that leaves only one thing to fill the gap, and that's government.

And that -- let me -- two aspects of that: you know, a stimulus that we had has made a difference. You know, some people say, well, look, we still have 10 percent unemployment. That's not the right question. If we hadn't had that stimulus, the unemployment rate would have been 11 (percent) or 12 percent.

Now, it was not big enough. That's clear in retrospect. I thought it was not big enough at the time. It was not well enough designed. One of the things that it didn't do was to take into account the problems of the states and localities. The state and localities have budget -- balanced-budget frameworks. When their revenues go down, they have to cut back. And their revenues are down over $200 billion a year. Perfectly understandable: Property taxes are a very important part. Property values are down, but also income is down.

So this is something that we should have known about because of the Great Depression. One of the things that -- the reason the New Deal was not as effective as one would have hoped was that, while the federal government at that time was increasing spending, state and local governments were contracting. And the same thing is going on now. So you have almost half of the federal stimulus offset by contraction at the state and local level.

Now, that's going to get worse with the end of the stimulus in 2011. And so you asked me now, what is the single most important thing to do, is to pass a second stimulus -- better designed, hopefully.

But you have to be able to walk and chew gum at the same time, and Congress obviously has to -- and the administration -- have to do more than one thing. They -- you know, you can't say, what is the one thing? One thing is obviously, I think, the stimulus.

But you have to deal with the mortgages. In 2008, when we were giving this massive bailout to the banks, what I said is it's like a mass blood transfusion to a patient dying from internal hemorrhaging, and not doing anything about the internal bleeding -- which were the mortgages. Now, we finally did something about that, but what we did was not enough and was not the right thing. So this year, 2010, we're expecting 2-1/2 (million) to 3-1/2 million foreclosures, more than in 2008 and (200)9. So things are getting -- again getting worse.

So I think we have to do something about the foreclosures. I describe there what we ought to do. And it is -- in the banking, we not only have to change the regulatory framework so this doesn't recur, but one of the real challenges is, how do we get lending started? Remember, when we began the bailout of banks, we said it wasn't for love of the banks, but because it was necessary to increase the lending. The lending didn't increase. And it's particularly, right now, hard for small- and medium-sized businesses, which are the source of job creation.

WEISMAN: Let's -- there are so many questions that that raises, but let's go to the international context, especially in the latter part of your answer about how we change the banking system. Is this a good time also to move aggressively on banking regulation? There are stories in the papers, even today, that the administration wants to curb the size of banks. Can we do those things, if they're advisable, without international cooperation, and what do you see the prospect for that?

STIGLITZ: Well, first, I think we do need to change the regulatory framework. The regulatory framework is an important part of the problem. And, you know, as an economist, the one thing -- economists don't agree about very much, but the one thing that they do agree is that incentives matter. And if you look at the incentives at the individual level and the organizational level, they're distorted. They encourage the kind of risk-taking that we got, and the kind of short-sighted behavior.

WEISMAN: Including the bonus structure.

STIGLITZ: The bonus structure, very clearly so; but also, you mention size. Size is another thing. When you have banks that are too big to fail, they gamble and they win, they walk off with the profits; they gamble and they lose, the taxpayer picks up the tab. And we've seen that.

And by the way, if this were the only time, you might say, okay, you know, accidents happen. But, you know, Jessica (sp) and I were working at the World Bank at the time of the East Asia crisis and, you know, there were all these crises with names of countries -- Indonesia, Korea, Thailand, Brazil, Argentina, Russia -- I can go on. But the point is, these are not country crises; these are banking crises.

The banks lent to, mainly -- in many cases, in East Asia it was the companies, for the most part; not the country -- companies, beyond their ability to pay. Sound familiar?

WEISMAN: Yes.

STIGLITZ: Same thing they did here. And what happened? They were bailed out. They were bailed out because, if you didn't bail them out, it was said it would create turmoil. And so, in a sense, they held a gun to the head of these countries. The taxpayers in those countries bailed out American banks and European banks. The only thing that's different about this crisis is, it's American taxpayers, rather than the taxpayers are poor people. And we, of course, feel much more upset when it's our taxpayers who are picking up the tab. So the -- I think it's welcome that they're beginning to discuss how do we change the incentives to get the banks to behave better.

Now, you asked the question: Do you need, you know, global cooperation?

WEISMAN: Right.

STIGLITZ: For my -- it would be best if we got that global cooperation, for one obvious reason. We live in a world of globalization, and the banks are very good at arbitrage -- at regulatory arbitrage as well as financial arbitrage, tax arbitrage.

WEISMAN: You mean investors, or whoever, moving their money to places where there is less regulation?

STIGLITZ: That's right. But the fundamental point is, and we've -- already going in this direction. Our main responsibility is to protect our economic system and our citizens, and we can do that even if other countries don't.

Right now, the feeling, I can tell you, in Europe is very much that we are dragging the feet. At the G-20 meetings, Europe was much more adamant about talking about regulation, and we were the people that didn't want to talk about it. So in fact, I think that if you laid out an agenda, you would -- you would get a lot more cooperation.

Mervyn King, the head of the Bank of England, has said very forcefully that the -- you know, if you're too big to fail, you're too big to be. (Chuckles.) And so, you know, they recognize this problem. France and the U.K. have said incentives that lead to excessive risk-taking have to be curbed for those institutions that can put at risk the entire economy.

WEISMAN: And there are some remarkable ideas coming out of Europe on -- even talk of a Tobin tax, financial transaction tax, fees on -- taxes on bonuses. But my question as an economist is, earlier you just said we need to get the banks to lend more. Is there a potential contradiction between these actions and also encouraging them to lend?

STIGLITZ: I don't think so, but obviously, policies have to be crafted -- well, I think, you know, go back to the -- going back to the theme that incentives matter, we have to design incentives to encourage lending. Right now, if you look at a lot of the provisions of our tax structure or the regulatory framework, we -- we're lending money to the banks at close to zero interest rate. And we say the reason we're doing it, the reason the Fed is giving money at this low interest rate, in part, is, as I say, to stimulate our economy. But we don't say, "By the way, you have to take the money that we're lending to you, and you have to lend it to other American firms." We don't say that. We don't want to put any constraints on them.

So what are they doing? They're taking the money, they're looking around the world and saying, where is the most -- the strongest economy? Where are they finding that? In the emerging markets. So what's interesting here is we're complaining because we're not getting the money for lending -- you know, small business, and medium-sized particularly, aren't getting money. But Brazil and China and other countries are complaining because they're getting speculative money that's creating a bubble in these countries. And they don't want to have another crisis. They've been through it.

They -- I mean, the interesting thing is that, having been through it, they've learned the lessons, and they have much better bank regulation than the United States. They have much better monetary policy than the United States. And that's why Brazil, for instance, has started imposing restrictions on the inflow of capital. And that's really undermining globalization.

WEISMAN: That's a good point to segue from into another question I wanted to ask you. This morning, the news from China is that China's economy is roaring ahead, and they're worried about inflation. And we have a question from one of our viewers in China, asking you about the -- what you think of the Chinese economy. But let me add to that, are we at risk of, as you suggested before, bubbles and, equally, buildup of foreign-currency reserves, foreign-exchange reserves, in countries like China, which many people feel contributed or were a factor in the -- what I think Chairman Bernanke calls, and Alan Greenspan called the global savings glut that contributed to the crisis? You're a skeptic of that view, but do you see a return to the problem of these huge global imbalances, as we struggle to recover?

STIGLITZ: Very much so. I mean, just as an aside, one of the reasons that China is recovering so well is they've read our textbooks. (Chuckles.) They studied good macroeconomics like we -- like we've taught, and they said --

WEISMAN: Did you sell any books?

STIGLITZ: Yes, my books is one of the best sellers there, my textbook. (Laughter.)

But, you know, the basic Keynesian idea is that, if you have a weak economy, spend, and spend very cleverly, because in the long run -- you know, what they're doing is they're trying to stimulate the economy in the short run, but do investments that provide the basis of long-run economic growth.

So one of the things they're spending on, one of the major things, is creating a high-speed railroad system. And just like the cross -- the intercontinental railroads changed America's economic geography, they're doing the same. And they now have the fastest trains in the world. And it really is -- you can really see how it is changing their economic geography, and is going to lead them to be in a position to have faster growth.

But now, to return to the question of the global imbalances, there are two aspects I want to comment on. You know, the first is, why are they saving so much? One of the reasons that -- one of the reasons that many of the countries in East Asia are saving so much is because they recognize that there's a lot of volatility in the world, and they have to rely on themselves for insurance, for self-insurance.

WEISMAN: And of course, their experience in the Asian crisis which led them to that, right?

STIGLITZ: That -- exactly. In fact, one -- the prime minister of one of these countries told me quite frankly, he said -- the way he put it was very amusing. He said, "We were in the class of '97." (Laughter.) You know, "We learned what happened when you don't have enough reserves." And he said, "Well, now, never again," he said, "would we allow that to happen." And so they built up the reserves, hundreds of billions of dollars a year put in reserves: increases their security, but that's money that's not spent, and money that's not spent doesn't -- leads to weaknesses in global aggregate demand. That's part of globalization; it's the whole global aggregate demand that matters.

Now, the way we've managed this crisis, the way things have evolved, things are worse, because which countries did better? The countries that had large reserves could undertake stimulus actions. And they've fared better.

Russia had about $600 billion of reserves before the crisis. They've lost a large fraction of that. But you know, you talk to any Russian government official. If they hadn't had those reserves, they would be in another -- they would really be back in '98, in the Ruble crisis.

So everybody looking at those examples, say, you have to have more reserves. Well, what does that mean? That means what you call a savings glut. But now this is -- the final point I want to make, the issue is not a savings glut.

When you talk about savings glut, it's a balance of savings on the one hand and investment. And I'd rather call it an investment dearth and a shortage of investment, not of investment needs.

I look around the world and I say, look, a billion people in extreme poverty, more than that, a couple billion people in poverty. We need to invest, to enable their standard of living to go up.

The world faces a problem of global warming. We have to retrofit the whole global economy. That's going to take a lot of investment. We're talking about -- how are we going to change our, you know, investment in energy -- new energy systems, new transportation systems.

That's going to take a lot of investment. So we shouldn't be telling people, don't save. We should be figuring out how to take the savings and transform that into productive investment. And that comes back to the big failure in this crisis: the failure of the financial system to do its job.

Its job is to take savings and transform them into the place where they have the highest return. Putting savings into housing beyond people's ability to pay, in the richest country in the world, is not the globally most useful place to put the savings.

And so it's a real -- from my point of view, it's another piece of evidence that our financial system didn't perform its social function.

WEISMAN: Let me ask a final question, before we go to the group, about American leadership and in particular about the role of the dollar. Do you see the dollar as being dethroned in this crisis? Is that a terrible thing that we should try and avoid? Or is it inevitable, given the way the economy, the global economy, is growing?

STIGLITZ: That's a good question. It's one that I spend some time talking about in the book "Freefall."

The dollar reserve system has already been fraying. It's -- you know, the world has been using dollars as the basis of their currencies and backing of their countries for a long time. But for a currency to be used as a reserve, as a storer of value, it has to be stable in value. And in the last decade, it's been highly volatile, very unstable.

And so there's been a big move out of the dollar. You can see it in China. It still holds $1.5 trillion of reserves. But it holds a large fraction not in dollars. But the crisis is going to accelerate that process. Particularly you know, you listen to the leaders of China, and they are very worried that they're holding $1.5 trillion of dollars.

And they are worried that -- we're not going to renege on our debt but that we will inflate away the debt. The value of the dollar will go down. And they -- you know, they started lecturing the United States, about managing its macropolicies, from their self-interest. And it's very clear that they will be trying to figure out ways of moving out of the dollar.

I chaired a U.N. commission on reform of the global economic and financial system. And our strongest recommendation for, you might say, medium-term reforms, although we thought it needed to be done as quickly as possible, was a new global reserve system.

I was just at a meeting with President Sarkozy the week before last. And you know, he put it in a way that I think a lot of people have said. It's very strange in a world of globalization, multilateral system, to have the currency of one country to be this asymmetric role in the global system.

And with China, Russia, France, a lot of other countries coming to that view, I think it is likely that we will move out of the dollar system. The real questions are, how fast? Do we do it in an orderly or disorderly way?

WEISMAN: And then there are dangers.

STIGLITZ: And in particular I -- what we do in our U.N. report and in the book -- you know, to try to explain how we can do it in an orderly way. I'm not necessarily hopeful that we'll do it that way. But one of the questions obviously that Americans want to know is, will it be bad for the U.S.? And now will it play in Peoria?

But here --

WEISMAN: Or Gary, Indiana?

STIGLITZ: (Laughs.) That's right.

I would argue that it actually would be good. And the reason, we get one advantage, and that's why we've resisted. And it was an old idea that Keynes actually wanted, to create a global reserve system. He called it a bancor.

But the U.S. vetoed that. And the reason obviously is that we get some advantage in being able to borrow at low interest rates, close to zero interest rates right now. And you know, obviously any of us would like to be able to borrow a couple trillion dollars at a zero interest rate. We could find some place to invest it at even 1 percent, and we'll be wealthy.

So you could understand the logic of that. But there's a flipside. And the flipside is the following. If people are buying U.S. dollars, what we're doing in effect is exporting dollars rather than exporting goods.

You know, the capital in-flow, the flipside of that, is a trade deficit. Well, when you export T-bills, you don't create jobs. And therefore the trade deficit contributes to the weak economy and to our problem of jobs.

So I think the transformation into this global reserve system will increase, if we do it in the right way, global aggregate demand and will be of benefit to the United States. And I think you can do it in a smooth way. But it's one of those things that's going to take a lot of work in the next few years.

WEISMAN: Great.

Let's go now to the audience, to join the discussion. Please wait for the microphone. Speak directly into it. State your name. Stand, state your name and affiliation. And please keep your questions and comments concise.

Rick.

QUESTIONER: Hedrick Smith with PBS.

Let's just go back to one of your basic questions earlier on. How do you get the banks lending again? I mean, that's critical. Is it regulation? Is it incentives? Is it a combination of the two?

STIGLITZ: Yeah, I think it's a combination of the two.

What we assumed, and this was the fundamental mistake, was that if we just recapitalized the banks, they would start lending. So we gave them money, and they would -- they would start lending.

But if you looked at their incentive structure, they did what their incentives led them to do. They took that money and they paid out bonuses and dividends. And you know, as an economist, I was not at all surprised.

So then you ask, what kinds of -- how do we change incentives? How do -- what kinds of regulations would do it? Well, part of my criticism of what we did is, we didn't have a vision of our whole overall financial system.

Some parts of our banking system, of our financial system, actually do lend. There are some small and community banks that are -- whose business model is to lend.

What we should have done is to recognize that's a characteristic of some of our banks, and get the funds to those banks, and recognize that some other banks are in basically a gambling casino.

I don't want to say that. But if you look at where they're making their money, it's in trading, which is another name for gambling. So what we should have done is take the money and allocate disproportionately to the lending institutions and not to the gambling institutions.

There are other things that -- other ideas that we can -- that we can do. For instance, one of our very successful programs -- banks don't like it, but it is a very successful program -- was CRA, Community Reinvestment Act, where you told the banks that you have to lend a certain fraction of your portfolio to underserved communities.

You could take the same concept and say to banks, if you're a bank, you have a charter. You have access to the Federal Reserve. Part of -- you know, of that -- with rights come responsibilities. And one of the responsibilities is to lend to small-and-medium-size enterprises.

You figure out who are the good businesses -- I mean, that's -- to lend to. But so in other words, we -- there are regulatory mechanisms and incentive mechanisms that would have led to more lending.

We could make a condition. If the Fed is lending at a low interest rate, you know, close to zero, the banks that get that money have to use that money for lending in America.

You know, why are we giving the value of assets -- the low interest rate -- and having them use that money to speculate and, as I said before, causing problems in Brazil or China or India and getting resentment there?

So it seems to me that there are both regulatory and incentive structure changes that would do -- would go some way. It's a hard problem, particularly in a recession.

QUESTIONER: How do you affect the mortgage market in particular?

STIGLITZ: Oh, now the mortgage market is I would say a separate but it's a related problem.

One of the reason why the lending problem is getting worse, for small-and-medium-size businesses, is that a large fraction of small-and-medium-size lending, business lending, is collateral-based. Collateral-based lending means they use their home or real -- other real estate to back their loan. But what's happened to property values? They've gone down a third. In some -- commercial real estate's even worse. In some places it's worse. That means they can't get the loans.

Though one of the proposals -- you know, one of the -- senator -- senatorial candidate in Illinois has proposed, for instance, using more of that money to go to the Small Business Administration to -- because of this collateral problem.

But -- switch back to -- what do you do about the mortgages? The fundamental problem in our mortgage market now is that one out of four homes with mortgages are underwater. That is, they owe more than the value of their house. And we know, when homes are underwater, the probability of default goes way up. What we should have done -- and there's a broad consensus on this -- what we should have done is found some way of writing down the value of the mortgage -- I mean, the value -- yeah, of what they owe.

We do this kind of thing all of the time effectively in other areas. We have a very good bankruptcy law, I think, Chapter 11, that says if you owe more money than you can pay, you -- the firm goes bankrupt; it continues to operate, because you want to continue jobs. And what you do is, the shareholders lose everything and the bondholders then become the new shareholders, and the enterprise continues.

I've argued for a homeowners' Chapter 11 that would do the same thing that we -- keeping people in their home is as important as keeping people's jobs. It's important for the communities; it's important for our society. There are ways of -- you sometimes call it equitization; there are ways of doing it that are -- that -- you know, there are a lot of details that I've tried to describe, and I do talk about this particular idea in the book.

So the point is, what we did is, effectively, we did nothing about writing down the value of the mortgage. What we did is allow the banks to do what they know how -- best, which is stretch out the payments a little longer, charge them another fee for restructuring it; the government gives a little subsidy to the bank and a little subsidy to the homeowner; and so they can make their payments for a little bit longer, but they're still underwater. The bank can record a profit, because it's charged another fee, and the problems are pushed down the road by another year or two years, and we're going to get -- you know, a few million more foreclosures.

WEISMAN: Let's go here, the gentleman, and then --

QUESTIONER: I'm just -- (off mike) -- some kind of Glass-Steagalls (sic/Steagall) help with that lending problem.

WEISMAN: Could we go to the -- also to --

STIGLITZ: Okay --

QUESTIONER: -- identify -- yeah.

WEISMAN: All right, we'll --

STIGLITZ: Yeah.

WEISMAN: -- take that, and then we'll go to the gentleman.

STIGLITZ: Yeah. Okay, yeah.

I think Paul Volcker has said some -- I've agreed with almost everything he's said. You know, he said that the banks are too big to fail; they're -- also, most of these banks are too big to be managed; and also, that part of -- they're too big to regulate and -- effectively, and one of the real problems is they're undertaking this excess risk.

And the real problem is, when they undertake risk, it's at our expense. You know, if I go to Las Vegas and lose, it's -- I suffer, my family suffer. But the taxpayer doesn't pick up the tab. If the banks undertake this risk, particularly on their proprietary accounts, their own -- their own gambling on their own behalf -- but if they lose, we're picking up the tab.

WEISMAN: But could we go back to Glass-Steagall? Or is there some other way to --

STIGLITZ: Well, something like Glass-Steagall. I mean, obviously, you don't want the same law that described the world for 1930 for the 21st century. But the basic notion that you ought to restrict the kinds of activities that the banks that are the core part of our payment mechanism, that take ordinary people's money -- that core part of our banking system has to be protected. It shouldn't be writing nontransparent derivatives that, you know, are so nontransparent and so complex, one day AIG says, oh, we have a $10-billion shortage, and a few days later -- or a few hours later, it's 89 billion (dollars), and we wind up paying a whole 180 billion (dollars).

Now, we don't want that kind of complexity on our taxpayer. If there are other people who want to engage in that gambling -- you know, we have a diverse financial system. That's part of the strength of our country. You don't have to have everybody doing the same thing -- though it's not like these risk services will disappear.

The only question -- who does that -- are there any important economies of scope and economies of scale? And there is no evidence that the economies of scale and scope are sufficiently great to outweigh the risks and the distortions that arise. The big banks are effectively being subsidized. That allows them to have an advantage. And we have in place now a dynamic that is leading to increasing size, concentration.

After the repeal of Glass-Steagall, one of the disturbing things that happened were the kinds of conflicts that we got at Enron and WorldCom. Another one was the kind of risk-taking. But a third one was a marked increase in the concentration of our financial system. And that really, I think, undermines the competitiveness of our economy.

WEISMAN: Gentleman.

QUESTIONER: Sewell Chan from The New York Times. How significant is the president's proposal today to limit the size of banks? I mean, you've just addressed that in your question a little bit, but in terms of the broader political economy, do you see this as probably the biggest announcement from the administration so far?

STIGLITZ: I think it's very important. I have not read the details, so I can't respond to the details. But in terms of the principle, I think it's one of the most important things that needed to have been addressed. And again, I do talk about it in my book. It's a matter of incentives. I mean, the interesting thing is, not only do economists agree -- incentives, the banks evidently do, because they keep talking about incentive pay. And if they realize that incentives are important, they have to realize this incentive problem.

Now, what they always said was, we can fix it by these notions of living wills and resolution authority. But what they didn't -- you know, what they should have realized is, in the time of crisis, the living wills won't work, and resolution authority is not going to work. What really stopped us from -- we had a lot more powers than we used. The reason we did what we did is because, at that moment of crisis, everybody gets afraid of roiling the market, what it will do. And having more power isn't going to stop that fear, that fear factor, which is -- really drove policy.

So if you're going to avoid the problem -- I mean, if you're going to deal with the problem, you have to avoid it arising. If you're going to avoid it arising, you have to limit the size. And, as I say, no one has shown any overall benefit to our economy from these big banks. But what they have shown is real consequences, adverse consequences in terms of risk.

What I argue in the book is that you actually have to take a comprehensive approach -- regulation, restricting size and incentives. And part of the other proposal the Obama administration made last week I think also was helpful on this. Because what they said is, the big banks will have to pay a higher -- a fee, but it's a fee that's related to their liabilities, so it also affects their incentives for excess risk-taking, which is really what puts the burden on our shoulders.

WEISMAN: Let's go back here. Bob, and then I'll come down here to you.

QUESTIONER: Bob Kaiser of The Washington Post. I wonder if you could give us your evaluation of the one comprehensive attempt so far, the House of Representatives bill that was passed in December, the regulatory-reform package.

STIGLITZ: Well, you might say it's a move in the right direction, but far, far short of what was needed. And let me just sort of highlight two things besides what I've talked about so far. We haven't -- you know, about the too-big-to-fail. It didn't deal with that really effectively.

One shortfall, in my judgment, was, if I remember correctly, it gave regulatory authority -- you -- it recognized you needed somebody to look at the overall stability of the financial system, that you need a financial-sector regulator. But it gave that authority to the Fed. And the fact of the -- you know, one of the tests of a good regulatory reform that I talk about in my book "Freefall" is, if we had that particular regulation in place, or that reform in place, would it have prevented the current crisis?

Well, if you use that criteria, it doesn't look very good, because the Fed had more powers to regulate than it used. So if you give them even more power, that would have been more powers that they wouldn't have used. They had a flawed view of the world. They were captured -- intellectually captured -- by these notions of "bubbles don't exist," "we don't have the instruments to deal with it," "easier to clean up the mess than deal with it beforehand." So that's one criticism.

Second criticism, along those lines: It's not been a very transparent organization. You look at the governance; it has very -- really deep problems in the governance. So if you're going to give the Fed those powers, you have to change the transparency. You have to say, you're subjected to the Freedom of Information Act. They're challenging -- they're still appealing the -- I believe the Bloomberg -- a court decision on the Bloomberg case.

So if you -- if you're going to be part of the government, you have to obey the laws of the rest of the government, which includes transparency. So if you're -- you have to -- and you have to -- the way your officials get appointed have to be consonant with democratic principles. So they needed to have done something about that.

The other big flaw is derivatives. You know, this is a big point. You talk a lot about home mortgages. All that's very important, but we have to remember, the failures in one firm, AIG, have cost us $180 billion, and that's one part that we're probably not going to get very much of that repaid.

To talk about TARP getting paid, all that, $180 billion, we'll get something back, but we'll going to take a big bath on that. Now -- and the derivatives lead to this "too intertwined to fail," a whole set of other problems.

If you look what they did, it's totally inadequate. They say things like we're going to encourage movement to standardize products traded on exchanges, but by the way, we're going to allow the big banks to continue to trade non-transparent, over-the-counter products. Well, where are people making the money? They make money because -- with non-standard, non-transparent, the forces of competition don't work very well. And that's where the margins are. There's a lot of force going in that.

So the devil's going to be in the detail. And unfortunately, when you start thinking about how the regulatory framework works, the likelihood that we're going to have a lot of these non-transparent, over-the-counter, complex, risky products is very high. The bill really doesn't deal with it.

And the second problem is, they move it to the exchanges, but how do we know the exchanges are adequately capitalized? The problem with the exchange, who's going to pick up -- who's going to pick up the bill? We're going to pick up the bill again.

Now, one way of dealing with this, for instance, is to say we're going to require standardized products, we're going to require them to trade on the exchanges, and we're going to make joint and several liability for everybody trading. So before they come to the taxpayer, those who are participating in this market are going to pick up the losses.

My own suspicion is that if you made them pay for the full cost of what is going on, there would be much less trading in these markets; that these markets in part exist because they're being implicitly subsidized.

WEISMAN: Paula.

QUESTIONER: Thank you. Joe, in your dialogue --

WEISMAN: Introduce yourself.

QUESTIONER: Oh, I'm sorry. Paula Stern, Stern Grouping. In your dialogue with Steve, you talked about the drying up of the consumer economy here in the U.S., and then you said that leaves government spending. So I would like to ask what your prescriptions are regarding government spending, leaving aside the defense expenditures for our wars that we're in right now.

Would you envision an infrastructure bank? Do you think the Department of Energy has been funded enough with these tens of billions of dollars for loans and grants for more greening of the economy, as you suggested? Can you give us an idea what you would do if you were king of the United States?

STIGLITZ: There are several -- I try to lay out in the book the criteria for what is a good spending program. But let me talk about two features, because there is a lot of worry right now about the increasing size of the national debt and the size of the deficits. There are two characteristics that are critical. One is the bang for the buck; the size of the multipliers, economists say. Some kinds of spending have bigger multipliers than others. The lowest multiplier is war spending. You know, you spend money in Afghanistan or Iraq. It doesn't come back to the United States. You pay a foreign contractor. There are no multipliers, effectively. So that's the kind of spending that doesn't promote economic growth here in the United States.

The second criteria is long-run returns. I talked about how China was investing in creating a national railroad system. We did a study when I was chairman of the Council of Economic Advisers on the returns to government spending on R&D technology, rates of return of unbelievable -- 50, 70 percent. And it's understandable when you realize, you know, something like the Internet, that transformed our society, was financed by government spending. Not every project works, but they've had some gold mines. So -- but infrastructure, education, all of those yield returns.

I did a calculation which shows that with reasonable values of the parameters, all you'd need is to get a 6 percent real return on your investment to result in a long-run reduction in the national debt. So, yes, when you've made -- like anybody when they borrow, when a company borrows, its liabilities go up, but if it invests well and makes a profit and it pays back the debt, and its liabilities go down.

So you take this long-run perspective that all you need is a 6-percent return for a spending to stimulate the economy in the short run and reduce the debt in the long run. So that's basically the core of where I think we ought to be going.

WEISMAN: Unfortunately, we have time for only one more question. Way in the back.

Oh, let me say, before you ask your question, I just wanted to remind all participants that this meeting has been on the record.

QUESTIONER: Oh, I'm sorry. My name is Shu (ph), and I'm with the Voice of America. I write business stories for VOA.

The concern about a(n) asset bubble forming in China has been growing. I'm just wondering what's your thinking on that. Thank you.

STIGLITZ: Well, this is related to the problem that I've mentioned several times before, that with the high level of liquidity being provided by the Federal Reserve and some other central banks, and in a world of globalization, where there are no boundaries, when money is given to the banks, they can look anywhere in the world. And where they're seeing the best place in the world are the emerging markets, including China.

Now, China has some of its own responsibilities. Other countries have -- like Brazil, have taken actions to try to restrict the flow of hot money into the country to prevent the bubble. China's problem -- China already has those restrictions, but people are clever at circumvention. But it's also a question of China's own monetary policy that -- some of the ways they've conducted that that has led to the liquidity, that has contributed to what is, I would say, the beginning of worrisome.

Let me make one comment about bubbles. In the run-up to the current crisis, it became almost a mantra for the Fed to say things like "you can't tell a bubble until after it breaks." And what is true is you can't be sure, but all policymaking has to be done in the presence of uncertainty. And you can make statements about it being more and more likely.

So you look at the housing situation, you looked at a whole set of statistics, like house prices-to-income ratios, and they were going in areas that they have never been before. And, you know, you looked at what was happening to -- you know, a lot of this was subprime mortgage -- subprime -- you know, low-income housing, income -- for lower-income individuals. What was happening to most individuals in the United States? Their real income was falling. Real income in 2007, for the median -- for the people in the middle was lower than in 1999. Meanwhile, house prices were going through the roof. You don't have to have a Ph.D. to understand that that can't be -- that's probably a problem.

Now, as long as interest rates remained at 1 percent, you could manage. What was worse, what we did is we -- our financial system lent -- allowed people to borrow their maximum at that low interest rate, the maximum they could pay, assuming that it would remain at those low interest rates. But they'd never been at that level historically. And they encouraged -- the Fed encouraged people to take out variable-rate mortgages.

Well, with the variable-rate mortgage and the interest rate being at 1 percent, the probability was it wasn't going to go much lower. (Laughter.) And if the interest rates returned to more normal levels and people were being stretched at that point, what was going to happen? There was going to be a problem.

And when they had to sell their homes, with so many people in the same situation, house prices would go down and the bubble would come to an end. And because it was going to go on -- this is a macroeconomic phenomena, it would happen in all parts of the country. These were not isolated. Interest rates are not only -- you know, it was throughout the whole country. We would have correlated risk all around the country. So the view that these would be uncorrelated risk was absurd.

So the point I want to make is, in looking bubbles, you can't be sure, but you have to look at some of the factors, and as the prices get higher and higher, you ought to get more and more anxious. And there are instruments that are available to try to dampen these. You don't have to have an on-off switch. There are instruments. You could have started to raise the down payment requirements. You raise the standards of lending.

QUESTIONER (?): Interest rates.

STIGLITZ: Interest rates would be one. That one is a two-edged sword because you have to look at the effects on other parts of the economy. But you could -- you know, for an economy where you have more controls, you could start imposing capital gains taxes to discourage speculative activity. In the United States, we could have reduced some of the deductibility on interest. That would have discouraged excess leverage. So there are lots of instruments available that can curb -- you know, it goes back to the theme of incentives matter. There are lots of instruments, lots of controls that could have shaped what was going on and that would have dampened the bubble and avoided it reaching the level that it's gone.

And I think those are lessons, I think, that China should bear in mind as well.

UNAUTHORIZED REPRODUCTION, REDISTRIBUTION OR RETRANSMISSION CONSTITUTES A MISAPPROPRIATION UNDER APPLICABLE UNFAIR COMPETITION LAW, AND FEDERAL NEWS SERVICE, INC. RESERVES THE RIGHT TO PURSUE ALL REMEDIES AVAILABLE TO IT IN RESPECT TO SUCH MISAPPROPRIATION.

FEDERAL NEWS SERVICE, INC. IS A PRIVATE FIRM AND IS NOT AFFILIATED WITH THE FEDERAL GOVERNMENT. NO COPYRIGHT IS CLAIMED AS TO ANY PART OF THE ORIGINAL WORK PREPARED BY A UNITED STATES GOVERNMENT OFFICER OR EMPLOYEE AS PART OF THAT PERSON'S OFFICIAL DUTIES.

FOR INFORMATION ON SUBSCRIBING TO FNS, PLEASE CALL CARINA NYBERG AT 202-347-1400.

THIS IS A RUSH TRANSCRIPT.

STEVEN R. WEISMAN: Good morning, everybody. Welcome to today's Council on Foreign Relations meeting with Professor Joseph Stiglitz. My name is Steve Weisman. I'm editorial director and public policy fellow at the Peterson Institute for International Economics.

I'd also like to welcome members of the Council on Foreign Relations around the world who are participating in this meeting via teleconference -- very exciting to have you.

The usual reminder to please completely turn off and not just put on vibrate your cell phones, BlackBerrys, wireless devices, social networking devices --

JOSEPH E. STIGLITZ: (Laughs.)

WEISMAN: -- to -- it's to avoid interference with the sound system. And as a final reminder, this meeting is on the record.

It's a pleasure and an honor to present Professor Stiglitz, professor of economics at Columbia and possessor of the Nobel Prize in economics, as well as many battle scars --

STIGLITZ: (Laughs.)

WEISMAN: -- from his time in the Clinton administration when he was chairman of the Council of Economic Advisers, and at the World Bank when he was chief economist and a lively and acerbic critic of the policies of the IMF in the Asian financial crisis. Many of those critiques have come back to sound familiar.

After 9/11, we learned the phrase "asymmetrical warfare." But long before that, Mr. Stiglitz pioneered the concept of asymmetry in economics in which he showed that markets do not function in a pure way, because the various parties have different levels of information and sophistication. And that work transformed economics and led to the insights that he brought to the ensuing crises and to the current crisis.

I won't summarize his views. He's better at that than anyone. His book is in the lobby -- his new book "Freefall," which I've enjoyed reading. And without further ado, let me start off with questions for about a half hour, and then we'll take questions from the audience.

Well, we are meeting at a very tumultuous week, politically. We're not going to talk about health care today, unless someone insists. But let me ask you first, Dr. Stiglitz, to frame the discussion about where you think the economy and the world economy is right now. What kind of moment is this? And if we're coming out of this recession, what do you think is the most urgent agenda item for this Congress, which would be, what, another stimulus, more regulation of the banking system, bank tax, bank fee, tax on bonuses?

STIGLITZ: (Chuckles.) Okay. Those are big questions. But let just begin by saying, you know, obviously we've pulled back from the precipice that the economy felt that it was on a year ago last fall. But I don't think anybody would describe the current situation as a strong recovery. Officially, the recession may be over in the way the economists define recession, which is two-quarters of negative growth -- (if ?) growth is positive -- but in terms of the way individuals feel, they worry about jobs, the way business feels, whether they can sell the goods they produce -- in those terms, the recession is far from over.

In terms of jobs, the official unemployment rate is 10 percent. But that number really masks what -- how bad things are. You're not unemployed if you're not seeking a job. And we've had this recession going so -- on so long that a lot of people who would like a job have just given up, have given up looking for a job. And those aren't included in the unemployed.

So if you take -- but the Bureau of Labor Statistics collects data on that, and there's -- so there's a broader measure of unemployment that includes those who have taken a part-time job because it's the only job available; who've dropped out of the labor force because there are no jobs. That broader number is now over 19 percent. So almost one out of five Americans who would like a full-time job cannot get one now. So this is -- this is a serious situation.

Four out of 10 of those who are unemployed, in the official statistic, have been unemployed for more than a half a year. That's important, because if you're unemployed just for a few weeks, you have something to draw upon and you have -- you know, if you're unemployed for more than six months, you use up your savings and you start actually deteriorating your human capital --

WEISMAN: Right.

STIGLITZ: -- as -- and the prospects of reemployment in a good job go way down. So for all these workers who've been unemployed now, for, say, half a year, their prospects are getting bleaker and bleaker. And that's particularly true of those who are -- who are over 50.

If you look at particular categories of people in the United States, say, young Afro-Americans, the unemployment -- the official unemployment rate now is close to one out of two, 40 -- it's over 48 percent. So if you look in those statistics, things are very bad.

Now, you asked the question, how long is it going to be before we get back to normal? In some of what you hear -- and the media says, oh, jobs lag recovery. But the real fact is, the recovery hasn't been strong enough to create the jobs for the new entrants in the labor force. If every year we have about 1 percent -- growth of the labor force of about 1 percent, and productivity -- that is output per hour -- goes up by about 2 percent, that means if growth isn't over 3 (percent), 3-1/2 percent, it's not strong enough to create the jobs for the new entrants in the labor force. No one sees -- and things always can happen -- but no one sees growth in 2010 and 2011 being above that, let alone enough above that to get the unemployment rate down from 10 percent back to normal 5 percent. So when you're looking at the horizon, you have to be a little bit pessimistic.

The fundamental problem can be put maybe simply both nationally and globally as the following: Would it sustain the American economy and to some extent the global economy in the years before the crisis was a bubble? The bubble allowed people to live beyond their means, in a sense. They could -- they could borrow. They could -- in one year alone, people took $950 billion out of their house. Savings rate for the United States went down to zero.

One of my predecessors, as chairman of the Council of Economic Advisers, said what -- that which is unsustainable won't be sustained. (Soft laughter.) And a savings rate of zero is not sustainable. So savings has gone up.

With -- the flip side of that is consumption has gone down. For the long run, that's a good thing. For the short run, it's a problem. So it's a little bit ironic that, you know, now a lot of people are saying we're praying for the consumer to come back. Well, that's a funny kind of prayer, because it's praying to go back to this dream world that we had before the crisis where we were living beyond our means. And we can't and we shouldn't do that. Because we can't and we probably won't, it's going to be hard to have a robust recovery.

So then that comes to the last part of your question. With consumption weak, it's very hard to have strong investment. In the past, like in the '97-'98 crisis, when Korea, for instance, had a problem, it recovered very quickly, but largely based on exports. But with Europe having a problem, the U.S. having a problem, we all can't export our way out of the crisis.

You know, I jokingly say, you know, trade with Mars is still not big enough. (Soft laughter.) So the fact is that because all of us are there in the same boat, exports is not going to be able to get out.

Now, one part of the world, Asia, is recovering, but while Asia is very dynamic, relative to Europe and the United States, it's just too small to make up for the shortfall. And that leaves only one thing to fill the gap, and that's government.

And that -- let me -- two aspects of that: you know, a stimulus that we had has made a difference. You know, some people say, well, look, we still have 10 percent unemployment. That's not the right question. If we hadn't had that stimulus, the unemployment rate would have been 11 (percent) or 12 percent.

Now, it was not big enough. That's clear in retrospect. I thought it was not big enough at the time. It was not well enough designed. One of the things that it didn't do was to take into account the problems of the states and localities. The state and localities have budget -- balanced-budget frameworks. When their revenues go down, they have to cut back. And their revenues are down over $200 billion a year. Perfectly understandable: Property taxes are a very important part. Property values are down, but also income is down.

So this is something that we should have known about because of the Great Depression. One of the things that -- the reason the New Deal was not as effective as one would have hoped was that, while the federal government at that time was increasing spending, state and local governments were contracting. And the same thing is going on now. So you have almost half of the federal stimulus offset by contraction at the state and local level.

Now, that's going to get worse with the end of the stimulus in 2011. And so you asked me now, what is the single most important thing to do, is to pass a second stimulus -- better designed, hopefully.

But you have to be able to walk and chew gum at the same time, and Congress obviously has to -- and the administration -- have to do more than one thing. They -- you know, you can't say, what is the one thing? One thing is obviously, I think, the stimulus.

But you have to deal with the mortgages. In 2008, when we were giving this massive bailout to the banks, what I said is it's like a mass blood transfusion to a patient dying from internal hemorrhaging, and not doing anything about the internal bleeding -- which were the mortgages. Now, we finally did something about that, but what we did was not enough and was not the right thing. So this year, 2010, we're expecting 2-1/2 (million) to 3-1/2 million foreclosures, more than in 2008 and (200)9. So things are getting -- again getting worse.

So I think we have to do something about the foreclosures. I describe there what we ought to do. And it is -- in the banking, we not only have to change the regulatory framework so this doesn't recur, but one of the real challenges is, how do we get lending started? Remember, when we began the bailout of banks, we said it wasn't for love of the banks, but because it was necessary to increase the lending. The lending didn't increase. And it's particularly, right now, hard for small- and medium-sized businesses, which are the source of job creation.

WEISMAN: Let's -- there are so many questions that that raises, but let's go to the international context, especially in the latter part of your answer about how we change the banking system. Is this a good time also to move aggressively on banking regulation? There are stories in the papers, even today, that the administration wants to curb the size of banks. Can we do those things, if they're advisable, without international cooperation, and what do you see the prospect for that?

STIGLITZ: Well, first, I think we do need to change the regulatory framework. The regulatory framework is an important part of the problem. And, you know, as an economist, the one thing -- economists don't agree about very much, but the one thing that they do agree is that incentives matter. And if you look at the incentives at the individual level and the organizational level, they're distorted. They encourage the kind of risk-taking that we got, and the kind of short-sighted behavior.

WEISMAN: Including the bonus structure.

STIGLITZ: The bonus structure, very clearly so; but also, you mention size. Size is another thing. When you have banks that are too big to fail, they gamble and they win, they walk off with the profits; they gamble and they lose, the taxpayer picks up the tab. And we've seen that.

And by the way, if this were the only time, you might say, okay, you know, accidents happen. But, you know, Jessica (sp) and I were working at the World Bank at the time of the East Asia crisis and, you know, there were all these crises with names of countries -- Indonesia, Korea, Thailand, Brazil, Argentina, Russia -- I can go on. But the point is, these are not country crises; these are banking crises.

The banks lent to, mainly -- in many cases, in East Asia it was the companies, for the most part; not the country -- companies, beyond their ability to pay. Sound familiar?

WEISMAN: Yes.

STIGLITZ: Same thing they did here. And what happened? They were bailed out. They were bailed out because, if you didn't bail them out, it was said it would create turmoil. And so, in a sense, they held a gun to the head of these countries. The taxpayers in those countries bailed out American banks and European banks. The only thing that's different about this crisis is, it's American taxpayers, rather than the taxpayers are poor people. And we, of course, feel much more upset when it's our taxpayers who are picking up the tab. So the -- I think it's welcome that they're beginning to discuss how do we change the incentives to get the banks to behave better.

Now, you asked the question: Do you need, you know, global cooperation?

WEISMAN: Right.

STIGLITZ: For my -- it would be best if we got that global cooperation, for one obvious reason. We live in a world of globalization, and the banks are very good at arbitrage -- at regulatory arbitrage as well as financial arbitrage, tax arbitrage.

WEISMAN: You mean investors, or whoever, moving their money to places where there is less regulation?

STIGLITZ: That's right. But the fundamental point is, and we've -- already going in this direction. Our main responsibility is to protect our economic system and our citizens, and we can do that even if other countries don't.

Right now, the feeling, I can tell you, in Europe is very much that we are dragging the feet. At the G-20 meetings, Europe was much more adamant about talking about regulation, and we were the people that didn't want to talk about it. So in fact, I think that if you laid out an agenda, you would -- you would get a lot more cooperation.

Mervyn King, the head of the Bank of England, has said very forcefully that the -- you know, if you're too big to fail, you're too big to be. (Chuckles.) And so, you know, they recognize this problem. France and the U.K. have said incentives that lead to excessive risk-taking have to be curbed for those institutions that can put at risk the entire economy.

WEISMAN: And there are some remarkable ideas coming out of Europe on -- even talk of a Tobin tax, financial transaction tax, fees on -- taxes on bonuses. But my question as an economist is, earlier you just said we need to get the banks to lend more. Is there a potential contradiction between these actions and also encouraging them to lend?

STIGLITZ: I don't think so, but obviously, policies have to be crafted -- well, I think, you know, go back to the -- going back to the theme that incentives matter, we have to design incentives to encourage lending. Right now, if you look at a lot of the provisions of our tax structure or the regulatory framework, we -- we're lending money to the banks at close to zero interest rate. And we say the reason we're doing it, the reason the Fed is giving money at this low interest rate, in part, is, as I say, to stimulate our economy. But we don't say, "By the way, you have to take the money that we're lending to you, and you have to lend it to other American firms." We don't say that. We don't want to put any constraints on them.

So what are they doing? They're taking the money, they're looking around the world and saying, where is the most -- the strongest economy? Where are they finding that? In the emerging markets. So what's interesting here is we're complaining because we're not getting the money for lending -- you know, small business, and medium-sized particularly, aren't getting money. But Brazil and China and other countries are complaining because they're getting speculative money that's creating a bubble in these countries. And they don't want to have another crisis. They've been through it.

They -- I mean, the interesting thing is that, having been through it, they've learned the lessons, and they have much better bank regulation than the United States. They have much better monetary policy than the United States. And that's why Brazil, for instance, has started imposing restrictions on the inflow of capital. And that's really undermining globalization.

WEISMAN: That's a good point to segue from into another question I wanted to ask you. This morning, the news from China is that China's economy is roaring ahead, and they're worried about inflation. And we have a question from one of our viewers in China, asking you about the -- what you think of the Chinese economy. But let me add to that, are we at risk of, as you suggested before, bubbles and, equally, buildup of foreign-currency reserves, foreign-exchange reserves, in countries like China, which many people feel contributed or were a factor in the -- what I think Chairman Bernanke calls, and Alan Greenspan called the global savings glut that contributed to the crisis? You're a skeptic of that view, but do you see a return to the problem of these huge global imbalances, as we struggle to recover?

STIGLITZ: Very much so. I mean, just as an aside, one of the reasons that China is recovering so well is they've read our textbooks. (Chuckles.) They studied good macroeconomics like we -- like we've taught, and they said --

WEISMAN: Did you sell any books?

STIGLITZ: Yes, my books is one of the best sellers there, my textbook. (Laughter.)

But, you know, the basic Keynesian idea is that, if you have a weak economy, spend, and spend very cleverly, because in the long run -- you know, what they're doing is they're trying to stimulate the economy in the short run, but do investments that provide the basis of long-run economic growth.

So one of the things they're spending on, one of the major things, is creating a high-speed railroad system. And just like the cross -- the intercontinental railroads changed America's economic geography, they're doing the same. And they now have the fastest trains in the world. And it really is -- you can really see how it is changing their economic geography, and is going to lead them to be in a position to have faster growth.

But now, to return to the question of the global imbalances, there are two aspects I want to comment on. You know, the first is, why are they saving so much? One of the reasons that -- one of the reasons that many of the countries in East Asia are saving so much is because they recognize that there's a lot of volatility in the world, and they have to rely on themselves for insurance, for self-insurance.

WEISMAN: And of course, their experience in the Asian crisis which led them to that, right?

STIGLITZ: That -- exactly. In fact, one -- the prime minister of one of these countries told me quite frankly, he said -- the way he put it was very amusing. He said, "We were in the class of '97." (Laughter.) You know, "We learned what happened when you don't have enough reserves." And he said, "Well, now, never again," he said, "would we allow that to happen." And so they built up the reserves, hundreds of billions of dollars a year put in reserves: increases their security, but that's money that's not spent, and money that's not spent doesn't -- leads to weaknesses in global aggregate demand. That's part of globalization; it's the whole global aggregate demand that matters.

Now, the way we've managed this crisis, the way things have evolved, things are worse, because which countries did better? The countries that had large reserves could undertake stimulus actions. And they've fared better.

Russia had about $600 billion of reserves before the crisis. They've lost a large fraction of that. But you know, you talk to any Russian government official. If they hadn't had those reserves, they would be in another -- they would really be back in '98, in the Ruble crisis.

So everybody looking at those examples, say, you have to have more reserves. Well, what does that mean? That means what you call a savings glut. But now this is -- the final point I want to make, the issue is not a savings glut.

When you talk about savings glut, it's a balance of savings on the one hand and investment. And I'd rather call it an investment dearth and a shortage of investment, not of investment needs.

I look around the world and I say, look, a billion people in extreme poverty, more than that, a couple billion people in poverty. We need to invest, to enable their standard of living to go up.

The world faces a problem of global warming. We have to retrofit the whole global economy. That's going to take a lot of investment. We're talking about -- how are we going to change our, you know, investment in energy -- new energy systems, new transportation systems.

That's going to take a lot of investment. So we shouldn't be telling people, don't save. We should be figuring out how to take the savings and transform that into productive investment. And that comes back to the big failure in this crisis: the failure of the financial system to do its job.

Its job is to take savings and transform them into the place where they have the highest return. Putting savings into housing beyond people's ability to pay, in the richest country in the world, is not the globally most useful place to put the savings.

And so it's a real -- from my point of view, it's another piece of evidence that our financial system didn't perform its social function.

WEISMAN: Let me ask a final question, before we go to the group, about American leadership and in particular about the role of the dollar. Do you see the dollar as being dethroned in this crisis? Is that a terrible thing that we should try and avoid? Or is it inevitable, given the way the economy, the global economy, is growing?

STIGLITZ: That's a good question. It's one that I spend some time talking about in the book "Freefall."

The dollar reserve system has already been fraying. It's -- you know, the world has been using dollars as the basis of their currencies and backing of their countries for a long time. But for a currency to be used as a reserve, as a storer of value, it has to be stable in value. And in the last decade, it's been highly volatile, very unstable.

And so there's been a big move out of the dollar. You can see it in China. It still holds $1.5 trillion of reserves. But it holds a large fraction not in dollars. But the crisis is going to accelerate that process. Particularly you know, you listen to the leaders of China, and they are very worried that they're holding $1.5 trillion of dollars.

And they are worried that -- we're not going to renege on our debt but that we will inflate away the debt. The value of the dollar will go down. And they -- you know, they started lecturing the United States, about managing its macropolicies, from their self-interest. And it's very clear that they will be trying to figure out ways of moving out of the dollar.

I chaired a U.N. commission on reform of the global economic and financial system. And our strongest recommendation for, you might say, medium-term reforms, although we thought it needed to be done as quickly as possible, was a new global reserve system.

I was just at a meeting with President Sarkozy the week before last. And you know, he put it in a way that I think a lot of people have said. It's very strange in a world of globalization, multilateral system, to have the currency of one country to be this asymmetric role in the global system.

And with China, Russia, France, a lot of other countries coming to that view, I think it is likely that we will move out of the dollar system. The real questions are, how fast? Do we do it in an orderly or disorderly way?

WEISMAN: And then there are dangers.

STIGLITZ: And in particular I -- what we do in our U.N. report and in the book -- you know, to try to explain how we can do it in an orderly way. I'm not necessarily hopeful that we'll do it that way. But one of the questions obviously that Americans want to know is, will it be bad for the U.S.? And now will it play in Peoria?

But here --

WEISMAN: Or Gary, Indiana?

STIGLITZ: (Laughs.) That's right.

I would argue that it actually would be good. And the reason, we get one advantage, and that's why we've resisted. And it was an old idea that Keynes actually wanted, to create a global reserve system. He called it a bancor.

But the U.S. vetoed that. And the reason obviously is that we get some advantage in being able to borrow at low interest rates, close to zero interest rates right now. And you know, obviously any of us would like to be able to borrow a couple trillion dollars at a zero interest rate. We could find some place to invest it at even 1 percent, and we'll be wealthy.

So you could understand the logic of that. But there's a flipside. And the flipside is the following. If people are buying U.S. dollars, what we're doing in effect is exporting dollars rather than exporting goods.

You know, the capital in-flow, the flipside of that, is a trade deficit. Well, when you export T-bills, you don't create jobs. And therefore the trade deficit contributes to the weak economy and to our problem of jobs.

So I think the transformation into this global reserve system will increase, if we do it in the right way, global aggregate demand and will be of benefit to the United States. And I think you can do it in a smooth way. But it's one of those things that's going to take a lot of work in the next few years.

WEISMAN: Great.

Let's go now to the audience, to join the discussion. Please wait for the microphone. Speak directly into it. State your name. Stand, state your name and affiliation. And please keep your questions and comments concise.

Rick.

QUESTIONER: Hedrick Smith with PBS.

Let's just go back to one of your basic questions earlier on. How do you get the banks lending again? I mean, that's critical. Is it regulation? Is it incentives? Is it a combination of the two?

STIGLITZ: Yeah, I think it's a combination of the two.

What we assumed, and this was the fundamental mistake, was that if we just recapitalized the banks, they would start lending. So we gave them money, and they would -- they would start lending.

But if you looked at their incentive structure, they did what their incentives led them to do. They took that money and they paid out bonuses and dividends. And you know, as an economist, I was not at all surprised.

So then you ask, what kinds of -- how do we change incentives? How do -- what kinds of regulations would do it? Well, part of my criticism of what we did is, we didn't have a vision of our whole overall financial system.

Some parts of our banking system, of our financial system, actually do lend. There are some small and community banks that are -- whose business model is to lend.

What we should have done is to recognize that's a characteristic of some of our banks, and get the funds to those banks, and recognize that some other banks are in basically a gambling casino.

I don't want to say that. But if you look at where they're making their money, it's in trading, which is another name for gambling. So what we should have done is take the money and allocate disproportionately to the lending institutions and not to the gambling institutions.

There are other things that -- other ideas that we can -- that we can do. For instance, one of our very successful programs -- banks don't like it, but it is a very successful program -- was CRA, Community Reinvestment Act, where you told the banks that you have to lend a certain fraction of your portfolio to underserved communities.

You could take the same concept and say to banks, if you're a bank, you have a charter. You have access to the Federal Reserve. Part of -- you know, of that -- with rights come responsibilities. And one of the responsibilities is to lend to small-and-medium-size enterprises.

You figure out who are the good businesses -- I mean, that's -- to lend to. But so in other words, we -- there are regulatory mechanisms and incentive mechanisms that would have led to more lending.

We could make a condition. If the Fed is lending at a low interest rate, you know, close to zero, the banks that get that money have to use that money for lending in America.

You know, why are we giving the value of assets -- the low interest rate -- and having them use that money to speculate and, as I said before, causing problems in Brazil or China or India and getting resentment there?

So it seems to me that there are both regulatory and incentive structure changes that would do -- would go some way. It's a hard problem, particularly in a recession.

QUESTIONER: How do you affect the mortgage market in particular?

STIGLITZ: Oh, now the mortgage market is I would say a separate but it's a related problem.

One of the reason why the lending problem is getting worse, for small-and-medium-size businesses, is that a large fraction of small-and-medium-size lending, business lending, is collateral-based. Collateral-based lending means they use their home or real -- other real estate to back their loan. But what's happened to property values? They've gone down a third. In some -- commercial real estate's even worse. In some places it's worse. That means they can't get the loans.

Though one of the proposals -- you know, one of the -- senator -- senatorial candidate in Illinois has proposed, for instance, using more of that money to go to the Small Business Administration to -- because of this collateral problem.

But -- switch back to -- what do you do about the mortgages? The fundamental problem in our mortgage market now is that one out of four homes with mortgages are underwater. That is, they owe more than the value of their house. And we know, when homes are underwater, the probability of default goes way up. What we should have done -- and there's a broad consensus on this -- what we should have done is found some way of writing down the value of the mortgage -- I mean, the value -- yeah, of what they owe.

We do this kind of thing all of the time effectively in other areas. We have a very good bankruptcy law, I think, Chapter 11, that says if you owe more money than you can pay, you -- the firm goes bankrupt; it continues to operate, because you want to continue jobs. And what you do is, the shareholders lose everything and the bondholders then become the new shareholders, and the enterprise continues.

I've argued for a homeowners' Chapter 11 that would do the same thing that we -- keeping people in their home is as important as keeping people's jobs. It's important for the communities; it's important for our society. There are ways of -- you sometimes call it equitization; there are ways of doing it that are -- that -- you know, there are a lot of details that I've tried to describe, and I do talk about this particular idea in the book.

So the point is, what we did is, effectively, we did nothing about writing down the value of the mortgage. What we did is allow the banks to do what they know how -- best, which is stretch out the payments a little longer, charge them another fee for restructuring it; the government gives a little subsidy to the bank and a little subsidy to the homeowner; and so they can make their payments for a little bit longer, but they're still underwater. The bank can record a profit, because it's charged another fee, and the problems are pushed down the road by another year or two years, and we're going to get -- you know, a few million more foreclosures.

WEISMAN: Let's go here, the gentleman, and then --

QUESTIONER: I'm just -- (off mike) -- some kind of Glass-Steagalls (sic/Steagall) help with that lending problem.

WEISMAN: Could we go to the -- also to --

STIGLITZ: Okay --

QUESTIONER: -- identify -- yeah.

WEISMAN: All right, we'll --

STIGLITZ: Yeah.

WEISMAN: -- take that, and then we'll go to the gentleman.

STIGLITZ: Yeah. Okay, yeah.

I think Paul Volcker has said some -- I've agreed with almost everything he's said. You know, he said that the banks are too big to fail; they're -- also, most of these banks are too big to be managed; and also, that part of -- they're too big to regulate and -- effectively, and one of the real problems is they're undertaking this excess risk.

And the real problem is, when they undertake risk, it's at our expense. You know, if I go to Las Vegas and lose, it's -- I suffer, my family suffer. But the taxpayer doesn't pick up the tab. If the banks undertake this risk, particularly on their proprietary accounts, their own -- their own gambling on their own behalf -- but if they lose, we're picking up the tab.

WEISMAN: But could we go back to Glass-Steagall? Or is there some other way to --

STIGLITZ: Well, something like Glass-Steagall. I mean, obviously, you don't want the same law that described the world for 1930 for the 21st century. But the basic notion that you ought to restrict the kinds of activities that the banks that are the core part of our payment mechanism, that take ordinary people's money -- that core part of our banking system has to be protected. It shouldn't be writing nontransparent derivatives that, you know, are so nontransparent and so complex, one day AIG says, oh, we have a $10-billion shortage, and a few days later -- or a few hours later, it's 89 billion (dollars), and we wind up paying a whole 180 billion (dollars).

Now, we don't want that kind of complexity on our taxpayer. If there are other people who want to engage in that gambling -- you know, we have a diverse financial system. That's part of the strength of our country. You don't have to have everybody doing the same thing -- though it's not like these risk services will disappear.

The only question -- who does that -- are there any important economies of scope and economies of scale? And there is no evidence that the economies of scale and scope are sufficiently great to outweigh the risks and the distortions that arise. The big banks are effectively being subsidized. That allows them to have an advantage. And we have in place now a dynamic that is leading to increasing size, concentration.

After the repeal of Glass-Steagall, one of the disturbing things that happened were the kinds of conflicts that we got at Enron and WorldCom. Another one was the kind of risk-taking. But a third one was a marked increase in the concentration of our financial system. And that really, I think, undermines the competitiveness of our economy.

WEISMAN: Gentleman.

QUESTIONER: Sewell Chan from The New York Times. How significant is the president's proposal today to limit the size of banks? I mean, you've just addressed that in your question a little bit, but in terms of the broader political economy, do you see this as probably the biggest announcement from the administration so far?

STIGLITZ: I think it's very important. I have not read the details, so I can't respond to the details. But in terms of the principle, I think it's one of the most important things that needed to have been addressed. And again, I do talk about it in my book. It's a matter of incentives. I mean, the interesting thing is, not only do economists agree -- incentives, the banks evidently do, because they keep talking about incentive pay. And if they realize that incentives are important, they have to realize this incentive problem.

Now, what they always said was, we can fix it by these notions of living wills and resolution authority. But what they didn't -- you know, what they should have realized is, in the time of crisis, the living wills won't work, and resolution authority is not going to work. What really stopped us from -- we had a lot more powers than we used. The reason we did what we did is because, at that moment of crisis, everybody gets afraid of roiling the market, what it will do. And having more power isn't going to stop that fear, that fear factor, which is -- really drove policy.

So if you're going to avoid the problem -- I mean, if you're going to deal with the problem, you have to avoid it arising. If you're going to avoid it arising, you have to limit the size. And, as I say, no one has shown any overall benefit to our economy from these big banks. But what they have shown is real consequences, adverse consequences in terms of risk.

What I argue in the book is that you actually have to take a comprehensive approach -- regulation, restricting size and incentives. And part of the other proposal the Obama administration made last week I think also was helpful on this. Because what they said is, the big banks will have to pay a higher -- a fee, but it's a fee that's related to their liabilities, so it also affects their incentives for excess risk-taking, which is really what puts the burden on our shoulders.

WEISMAN: Let's go back here. Bob, and then I'll come down here to you.

QUESTIONER: Bob Kaiser of The Washington Post. I wonder if you could give us your evaluation of the one comprehensive attempt so far, the House of Representatives bill that was passed in December, the regulatory-reform package.

STIGLITZ: Well, you might say it's a move in the right direction, but far, far short of what was needed. And let me just sort of highlight two things besides what I've talked about so far. We haven't -- you know, about the too-big-to-fail. It didn't deal with that really effectively.

One shortfall, in my judgment, was, if I remember correctly, it gave regulatory authority -- you -- it recognized you needed somebody to look at the overall stability of the financial system, that you need a financial-sector regulator. But it gave that authority to the Fed. And the fact of the -- you know, one of the tests of a good regulatory reform that I talk about in my book "Freefall" is, if we had that particular regulation in place, or that reform in place, would it have prevented the current crisis?

Well, if you use that criteria, it doesn't look very good, because the Fed had more powers to regulate than it used. So if you give them even more power, that would have been more powers that they wouldn't have used. They had a flawed view of the world. They were captured -- intellectually captured -- by these notions of "bubbles don't exist," "we don't have the instruments to deal with it," "easier to clean up the mess than deal with it beforehand." So that's one criticism.

Second criticism, along those lines: It's not been a very transparent organization. You look at the governance; it has very -- really deep problems in the governance. So if you're going to give the Fed those powers, you have to change the transparency. You have to say, you're subjected to the Freedom of Information Act. They're challenging -- they're still appealing the -- I believe the Bloomberg -- a court decision on the Bloomberg case.

So if you -- if you're going to be part of the government, you have to obey the laws of the rest of the government, which includes transparency. So if you're -- you have to -- and you have to -- the way your officials get appointed have to be consonant with democratic principles. So they needed to have done something about that.

The other big flaw is derivatives. You know, this is a big point. You talk a lot about home mortgages. All that's very important, but we have to remember, the failures in one firm, AIG, have cost us $180 billion, and that's one part that we're probably not going to get very much of that repaid.

To talk about TARP getting paid, all that, $180 billion, we'll get something back, but we'll going to take a big bath on that. Now -- and the derivatives lead to this "too intertwined to fail," a whole set of other problems.

If you look what they did, it's totally inadequate. They say things like we're going to encourage movement to standardize products traded on exchanges, but by the way, we're going to allow the big banks to continue to trade non-transparent, over-the-counter products. Well, where are people making the money? They make money because -- with non-standard, non-transparent, the forces of competition don't work very well. And that's where the margins are. There's a lot of force going in that.

So the devil's going to be in the detail. And unfortunately, when you start thinking about how the regulatory framework works, the likelihood that we're going to have a lot of these non-transparent, over-the-counter, complex, risky products is very high. The bill really doesn't deal with it.

And the second problem is, they move it to the exchanges, but how do we know the exchanges are adequately capitalized? The problem with the exchange, who's going to pick up -- who's going to pick up the bill? We're going to pick up the bill again.

Now, one way of dealing with this, for instance, is to say we're going to require standardized products, we're going to require them to trade on the exchanges, and we're going to make joint and several liability for everybody trading. So before they come to the taxpayer, those who are participating in this market are going to pick up the losses.

My own suspicion is that if you made them pay for the full cost of what is going on, there would be much less trading in these markets; that these markets in part exist because they're being implicitly subsidized.

WEISMAN: Paula.

QUESTIONER: Thank you. Joe, in your dialogue --

WEISMAN: Introduce yourself.

QUESTIONER: Oh, I'm sorry. Paula Stern, Stern Grouping. In your dialogue with Steve, you talked about the drying up of the consumer economy here in the U.S., and then you said that leaves government spending. So I would like to ask what your prescriptions are regarding government spending, leaving aside the defense expenditures for our wars that we're in right now.

Would you envision an infrastructure bank? Do you think the Department of Energy has been funded enough with these tens of billions of dollars for loans and grants for more greening of the economy, as you suggested? Can you give us an idea what you would do if you were king of the United States?

STIGLITZ: There are several -- I try to lay out in the book the criteria for what is a good spending program. But let me talk about two features, because there is a lot of worry right now about the increasing size of the national debt and the size of the deficits. There are two characteristics that are critical. One is the bang for the buck; the size of the multipliers, economists say. Some kinds of spending have bigger multipliers than others. The lowest multiplier is war spending. You know, you spend money in Afghanistan or Iraq. It doesn't come back to the United States. You pay a foreign contractor. There are no multipliers, effectively. So that's the kind of spending that doesn't promote economic growth here in the United States.

The second criteria is long-run returns. I talked about how China was investing in creating a national railroad system. We did a study when I was chairman of the Council of Economic Advisers on the returns to government spending on R&D technology, rates of return of unbelievable -- 50, 70 percent. And it's understandable when you realize, you know, something like the Internet, that transformed our society, was financed by government spending. Not every project works, but they've had some gold mines. So -- but infrastructure, education, all of those yield returns.

I did a calculation which shows that with reasonable values of the parameters, all you'd need is to get a 6 percent real return on your investment to result in a long-run reduction in the national debt. So, yes, when you've made -- like anybody when they borrow, when a company borrows, its liabilities go up, but if it invests well and makes a profit and it pays back the debt, and its liabilities go down.

So you take this long-run perspective that all you need is a 6-percent return for a spending to stimulate the economy in the short run and reduce the debt in the long run. So that's basically the core of where I think we ought to be going.

WEISMAN: Unfortunately, we have time for only one more question. Way in the back.

Oh, let me say, before you ask your question, I just wanted to remind all participants that this meeting has been on the record.

QUESTIONER: Oh, I'm sorry. My name is Shu (ph), and I'm with the Voice of America. I write business stories for VOA.

The concern about a(n) asset bubble forming in China has been growing. I'm just wondering what's your thinking on that. Thank you.

STIGLITZ: Well, this is related to the problem that I've mentioned several times before, that with the high level of liquidity being provided by the Federal Reserve and some other central banks, and in a world of globalization, where there are no boundaries, when money is given to the banks, they can look anywhere in the world. And where they're seeing the best place in the world are the emerging markets, including China.

Now, China has some of its own responsibilities. Other countries have -- like Brazil, have taken actions to try to restrict the flow of hot money into the country to prevent the bubble. China's problem -- China already has those restrictions, but people are clever at circumvention. But it's also a question of China's own monetary policy that -- some of the ways they've conducted that that has led to the liquidity, that has contributed to what is, I would say, the beginning of worrisome.

Let me make one comment about bubbles. In the run-up to the current crisis, it became almost a mantra for the Fed to say things like "you can't tell a bubble until after it breaks." And what is true is you can't be sure, but all policymaking has to be done in the presence of uncertainty. And you can make statements about it being more and more likely.

So you look at the housing situation, you looked at a whole set of statistics, like house prices-to-income ratios, and they were going in areas that they have never been before. And, you know, you looked at what was happening to -- you know, a lot of this was subprime mortgage -- subprime -- you know, low-income housing, income -- for lower-income individuals. What was happening to most individuals in the United States? Their real income was falling. Real income in 2007, for the median -- for the people in the middle was lower than in 1999. Meanwhile, house prices were going through the roof. You don't have to have a Ph.D. to understand that that can't be -- that's probably a problem.

Now, as long as interest rates remained at 1 percent, you could manage. What was worse, what we did is we -- our financial system lent -- allowed people to borrow their maximum at that low interest rate, the maximum they could pay, assuming that it would remain at those low interest rates. But they'd never been at that level historically. And they encouraged -- the Fed encouraged people to take out variable-rate mortgages.

Well, with the variable-rate mortgage and the interest rate being at 1 percent, the probability was it wasn't going to go much lower. (Laughter.) And if the interest rates returned to more normal levels and people were being stretched at that point, what was going to happen? There was going to be a problem.

And when they had to sell their homes, with so many people in the same situation, house prices would go down and the bubble would come to an end. And because it was going to go on -- this is a macroeconomic phenomena, it would happen in all parts of the country. These were not isolated. Interest rates are not only -- you know, it was throughout the whole country. We would have correlated risk all around the country. So the view that these would be uncorrelated risk was absurd.

So the point I want to make is, in looking bubbles, you can't be sure, but you have to look at some of the factors, and as the prices get higher and higher, you ought to get more and more anxious. And there are instruments that are available to try to dampen these. You don't have to have an on-off switch. There are instruments. You could have started to raise the down payment requirements. You raise the standards of lending.

QUESTIONER (?): Interest rates.

STIGLITZ: Interest rates would be one. That one is a two-edged sword because you have to look at the effects on other parts of the economy. But you could -- you know, for an economy where you have more controls, you could start imposing capital gains taxes to discourage speculative activity. In the United States, we could have reduced some of the deductibility on interest. That would have discouraged excess leverage. So there are lots of instruments available that can curb -- you know, it goes back to the theme of incentives matter. There are lots of instruments, lots of controls that could have shaped what was going on and that would have dampened the bubble and avoided it reaching the level that it's gone.

And I think those are lessons, I think, that China should bear in mind as well.

UNAUTHORIZED REPRODUCTION, REDISTRIBUTION OR RETRANSMISSION CONSTITUTES A MISAPPROPRIATION UNDER APPLICABLE UNFAIR COMPETITION LAW, AND FEDERAL NEWS SERVICE, INC. RESERVES THE RIGHT TO PURSUE ALL REMEDIES AVAILABLE TO IT IN RESPECT TO SUCH MISAPPROPRIATION.

FEDERAL NEWS SERVICE, INC. IS A PRIVATE FIRM AND IS NOT AFFILIATED WITH THE FEDERAL GOVERNMENT. NO COPYRIGHT IS CLAIMED AS TO ANY PART OF THE ORIGINAL WORK PREPARED BY A UNITED STATES GOVERNMENT OFFICER OR EMPLOYEE AS PART OF THAT PERSON'S OFFICIAL DUTIES.

FOR INFORMATION ON SUBSCRIBING TO FNS, PLEASE CALL CARINA NYBERG AT 202-347-1400.